There are several options available to you when creating your own at home business. The simplest is a sole proprietorship. Since I already have a day job, however, I wanted to create a new legal entity that would give me some protection. That is why I looked at the various options around incorporating. This article provides a good summary of the primary options available for incorporating your small business.

If you are interesting in incorporating then there are three basic options:

1. Regular corporation (C-Corp)
2. S-Corporation (S-Corp)
3. Limited Liability Company (LLC)

Regular Corporation

A C-Corp is a separate legal entity. It protects the owners of the company from personal liability and company debt. A C-Corp can enter into contracts, buy real estate and other assets, sue and be sued completely separate from the owners. With a C-Corp it is also easier to raise capital via the sale of stock. The ownership of the C-Corp can be transferred via the transfer of stock. In addition, there are tax advantages that can be rather significant (e.g., you can deduct many business expenses that other legal entities can’t). The income is reported via a separate tax return for the corporation.

There is a specific structure for a C-Corp:

1. Shareholders own the stock of the corporation
2. Directors (”Board of Directors”) are elected by the shareholders
3. Directors appoint Officers (President, Secretary, etc.)
4. Officers run the company

Quite often (especially in the startup phase) you are the sole, 100% owner of the stock. As a result, you elect the directors (typically yourself) and then appoint yourself as an officer (or all of the officers). The Corporate Bylaws dictate the operating rules for the corporation. Operating a C-Corp requires, at a minimum, holding an annual Directors and Shareholders meeting, keeping written minutes of significant company decisions, and maintaining general corporate compliance at directed by the bylaws.

A C-Corp structure is the oldest, most successful, and most prestigious type of business entity. It provides personal liability protection and can reduce taxes. A C-Corp is, however, more expensive to set up and there is more formality required to operate.

S-Corporation

An S-Corporation can be created after a corporation has already been created. This is done by electing “S-Corporation Status” and completing and submitting a form to the IRS. After filing for S-Corp status, the corporation will be taxed like a partnership or sole proprietorship rather than a corporation. This means that the income will be “passed-through” to the shareholders for the purposes of computing tax returns.

Most new, small corporations elect S-Corporation status (>90%). This is done so that profits and losses can be added to the shareholders’ personal tax returns without having to pay taxes on profits once, and then again when they are given back to the shareholders as income (dividends). This example of “double taxation” is one of the main reasons that S-Corporations were created. It is worth noting that an S-Corp can revert back to a C-Corp relatively easily.

Unlike a C-Corp, an S-Corp can not deduct expenses like health insurance, travel, entertainment, etc. An S-Corp is also restricted to 75 or fewer shareholders and all shareholders must be U.S. citizens. Like a C-Corp, an S-Corp requires some operating formalities like board meetings, keeping minutes, and so on.

Limited Liability Company (LLC)

An LLC is best thought of as a hybrid between a corporation and a partnership. Like a partnership (or sole proprietorship) the LLC provides easy management and “pass-through” taxation (i.e., profits/losses are added to the owner(s) personal tax returns). An LLC is similar to a corporation in that it provide liability protection. LLC’s are relatively new in concept (about 20 years old) but are now recognized by all 50 states and D.C.

While an LLC is a separate legal entity like a corporation there is no stock and there are fewer operating formalities. The owners of an LLC are referred to as “members” instead of “shareholders”. The rules are operating an LLC are spelled out in the LLC’s “Operating Agreement”. The Operating Agreement can be modified over time as the business grows and changes.

An LLC is the incorporation option of choice for most startups consisting of 1-5 people. The ease of management and limited compliance requirements have made the LLC a very user-friendly solution for small businesses.

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